If you've got a bank overdraft, it pays to be aware of the harsh way that banks can treat their customers.

They might call it a "free" overdraft, but nothing could be further from the truth. Okay, so they won't charge you an arrangement fee to let you borrow from them or a renewal fee to let you keep borrowing fro them. But that doesn't mean that the loan is interest free. Oh no, they'll still want their 20% APR for your "free" overdraft.

Rather misleading, isn't it?

Well that's just the start of your problems if you fall into the overdraft trap.

The other great danger is that you mistakenly borrow more than the bank has agreed to. That's when their unauthorised overdraft rules come into play. And they're even tougher than the normal rules. As if they weren't harsh enough already.

And just to give you an example of the severity of these rules it has been calculated that banks in the United Kingdom earn 3 billion each year through charges and interest on unauthorised overdrafts. That's more than 50 per person living in the UK!

So let's say your overdraft limit is 250. You spend some money and find yourself overdrawn to the sum of 251. One pound more than agreed. So their computer spits out a warning latter and charges you 25 for the privilege. So now you owe 276, which is being charged interest at perhaps 20% APR.

And you'll probably find that you have to pay a charge of 5-10 for every transaction that your account handles while you remain in unauthorised overdraft. So if you have any regular payments made from your account (eg direct debits, standing orders etc), you'll have more penalty payments added to your debt.

And then there's the unauthorised overdraft fee to consider. Many banks will charge you 30 a month for running an unauthorised overdraft. So you reach the position where your overdraft reaches 300 or more just becuase you want 1 over your limit.

And if you can't bring it back down to an agreed amount by the end of the month, you'll face another round of financial punishment. Some banks even increase their unauthorised overdraft fee each month that you remain over the agreed limit. So it might be 30 in the first month, then 75 in the second month, 120 in the third month and so on.

And above all that, we have to remember that all overdrafts in the UK are repayable on demand. That means the bank can ask you to repay the money you own them in full whenever they want.

But what if you can't get your overdraft back down to the agreed limit within the month? What happens if money is tight and you hadn't budgetted for such an unexpected amount?

Office Of Fair Trading Investigation

At the time of writing (May 2006) there is a campaign by the Office of Fair Trading (OFT) and the banking industry watchdog, the Banking Codes Standards Board (BCSB), to keep banking fees at a reasonable level. They want the charges to remain relative to the costs incurred by the bank.

For example, when you exceed your agreed overdraft and the bank have to send you a letter, the charge should only take account of the postage and stationery costs, and a fair share of the staff and equipment costs in maintaining the default system. Using these factors, the current target level is 12, which certainly seems more reasonable than the 25-30 levied by many lenders.

That may help to limit the amount of these charges, but with such a big profit at stake, the banks won't relinquish it without a fight. So in the meantime, here's how to avoid these excessive charges.

1) If possible avoid using an overdraft. If you have other debt, focus on clearing your overdraft first.

2) Until you clear your overdraft, find out exactly how far you are from the agreed overdraft limit before you buy anything. And don't forget to take automatic payments such as direct debits and standing orders into account.

3) If you do drift into unauthorised overdraft, contact your bank and explain the situation. Ask them to waive the penalty fees. If they won't, you'll have to pay up and make sure you get back within the agreed limit as soon as possible. Otherwise, they'll probably charge you a penalty fee for every transaction while you remain in unauthorised overdraft.

4) If you genuinely can't get back within the agreed limit the only other option to avoid further penalty charges is to contact your bank and ask them to increase the size of your overdraft. Hopefully, that will bring you back within an authorised limit.

But whatever happens, don't use that as an excuse to ease up on your efforts to eliminate your overdraft. Otherwise, you'll find yourself in the same position weeks/months later with an even larger overdraft.